NERI technical report no. 542. Jordrentetab ved arealekstensivering i landbruget. Principper og resultater. Schou, J.S. & Abildtrup, J. 2005. 66 pp.

Summary

Aim and background

The need for socio-economic analyses of environmental policies, e.g. the Water Framework Directive and national nature parks, call for consistent methods for estimation of the loss of economic rent resulting from extensified agricultural activities. The methodology is generally accepted among scientist and policy analysts, but the use of different data sources and various technical issues regarding remuneration of labour and capital has led to differing results.

This project was launched on this background in a collaboration between the Environmental Protection Agency, the Forest and Nature Agency, the National Environmental Research Institute and the Institute of Food Economics with the purpose of: developing guidelines for assessing the costs (loss of economic rent) of scenarios for termination or extensification of agricultural activities.

Measuring the economic rent

Costs of termination or extensification of agricultural activities are measured in terms of changes in economic rent. The economic rent is the remuneration of the production factor land measured as the residual after all other costs have been subtracted from the gross output (see box 0.1). The economic rent is measured in both financial and welfare economic terms. The financial economic analysis focuses on distributional effects, i.e. how a given initiative influences the economy of the affected agents (farmers, public administration, etc.). The welfare economic analysis focuses on the change in welfare for the whole of the Danish society. Also externalities are (in principle) included in the welfare economic analysis. But in practical policy analysis externalities are most often handled separately, and in this report only the effects related to marketed goods are included.

Remuneration of capital and labour

The value of the products sold off farm can as well as the value of traded inputs be assessed based on market prices. But for labour and capital the value assessment is connected with some problems. Regarding the value of labour this primarily relates to the value of the farmers own labour, which is often the dominating labour source on the smaller farms. As the internal reservation price of labour is only known by the farmer himself and, thus, cannot be found in statistics, this price is typically set equivalent to the labour price of a skilled worker. This is of cause a crude assumption, which may not be correct for a number of farmers, especially those who only have limited opportunities for alternative occupation.

Box 0.1 Calculation of financial and welfare economic rent.

Costs of capital should only cover those related to buildings, machinery, equipment, etc. and the remuneration is assessed using market based interest rates. One element of uncertainty is the assessment of the value of capital in buildings, as this needs to be separated from the land capital. In order to minimise possible bias related to this the distribution of capital between buildings and land has been analysed and the remuneration of buildings has been re-estimated. Further, all estimates are based on farm account statistics for larger farms with a standard gross margin above 2,2 M DKK (approximately 295,000 €). This is motivated by the fact that employed labour is dominated on these farms, and it therefore minimises the problems of assessing the right remuneration of the owner’s labour input.

Scenario analysis

The purpose of estimating changes in welfare economic rent resulting from changes in agricultural activities is to approximate the change in utility to society, and compare this with the expected benefits in cost benefit-analyses or with the costs of alternative measures resulting in similar environmental change in cost-efficiency analyses. These types of analyses most often include initiatives of the future (ex ante), and the estimates should therefore express the expected future change in utility. Usually this is dealt with by assuming that the historical economic rent will be indicative for the future. Therefore all analyses should be accompanied by an evaluation of whether this assumption is reasonable, and if arguments can be presented for other development paths, the analysis should reflect this by means of a sensitivity analysis.

Taking the starting point that the economic rent in a scenario analysis can be calculated based on historical farm account data, the next question is which data to use. The data used should reflect the analysed case in the best possible way. If a specific description of the implementation of activities in the case study area is developed, e.g. showing the number of farms affected and how they are affected, the evaluations should be based on this information. It is however, often seen that the case description is less specific, e.g. only specifying the number of hectares taken out of production at national level. In such cases it may be necessary to base the analysis on average statistics and more crude assumptions about the measures and their implementation.

The tenancy rent as guideline

To evaluate the validity of using average estimates of lost economic rent in case studies it is recommended to use the tenancy rent as a guideline for the financial economic rent. The tenancy rent represents the opportunity cost to the farmer of cropping the land himself. It should be stressed that even if the land is rented out some fixed costs occur to the owner, e.g. property taxes. Further, some caution should be applied at the evaluation of the tenancy rent, as other services, user rights and the like may be reflected in the price.

Recommendations

The analysis performed in the project has led to the following ten recommendations:

1. The analysis should reflect the structure of production, including soil quality and livestock production, characterising the case study area.
2. If possible a farm specific analysis should be performed, e.g. including the value of capital.
3. The possibilities of adjusting the farm capital of farms only partly affected by the extensification should be included.
4. The analysis can be based on general statistics as a first estimate or in cases where if a farm specific analysis is not possible. However, the recommendations under point 1,2 and 3 should be reflected.
5. General estimates of the economic rent should reflect the real remuneration of labour and capital.
6. General estimates should be based on farms with an optimal capital investment.
7. The financial economic rent should as a minimum correspond to the tenancy rent in the case study area.
8. If extensification of agricultural activities is to be executed within a short time-span, within which it is not possible to depreciate the farm capital, and if the capital has no other use, the estimates of economic rent should include the loss of capital. Similarly the loss of value added from labour should be included if idle labour is not expected to find alternative employment in the short term.
9. For specific projects an analysis of the optimal (cost-minimising) implementation-path should be included.
10. The economic rent from activities replacing the previous farming activities should be included in the analysis.

General estimates of the economic rent

The general estimates of economic rent from agricultural activities are based on farm account statistics from the Danish Food and Resource Economics Institute (www.foi.dk) and they are representative for the Danish agricultural sector. Table 0.1. shows the general estimates. Column 1 represents the economic rent from crop production, which can be taken as an estimate of the costs of extensifying agricultural activities without affecting livestock production. Column 2 shows the estimate, which also includes the contribution to the economic rent of livestock production, and can thus be taken as an estimate of the costs of extensifying agricultural activities where livestock production also is affected.

The validity of the assumptions regarding remuneration of labour and capital should be evaluated doing the actual case studies. Further, if reasonable arguments can be derived related to future changes in policies affecting the analysis, this should be reflected by means of sensitivity analyses.

Table 0.1 General estimates of economic rent from agriculture in DKK per ha. Five-years averages in 2005-prices, capital remuneration rate of 6% p.a. and discount rate of 3% p.a.

The CAP-reform

The main elements of the CAP-reform, which was implemented in the spring of 2005, is decoupling of the support from the volume of production, as hectare and livestock premiums are paid as a single farm payment. In order to be eligible to support one should have an agricultural area kept at a good agricultural and environmental level. In Table 0.2 the effects of the reform are summarised for four different scenarios of extensifying agricultural land.

Table 0.2 Effects of the CAP-reform for four different scenarios of extensifying agricultural land.

It is seen that the relative costs of different land use changes will change. Especially the costs for turning land in rotation into permanent pastures are reduced. This implies that the costs of establishing permanent pastures becomes less expensive than e.g. afforestation or other land use changes, which do not comply with the definition of agricultural use.

Identified gaps of knowledge

This project has identified a number of possibilities for validation of the estimates of the economic rent from agriculture based on existing market data. One example could be to use data for tenancy rents or analyse data from land redistribution projects. Further, the consequences of the CAP-reform are still uncertain both because new mechanisms for subsidy payments are introduced and because the farmers response to the new schemes are still to be seen. This call for a more thorough analysis of the consequences of the CAP-reform for the costs of different types of nature restoration projects. Last the issue of quantification of the external non-market effects for agricultural activities and nature restoration projects should be stressed, as this calls for performing further valuation studies and for development of guidelines for the use of the results in benefit transfer.

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